Email : info@otcjournal.com
URL : http://www.otcjournal.com
To
OTC Journal Members:
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The Fundamental
Side |
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We are about one third of the way
through June quarterly earnings season. I think it is fair to declare there
is a high probability the Bear Market is over. The market is emotionally
reactive to short term events, but over the long term generally gets it
right. The way the market trades today tells us where we will be in six
months.
After three years of total control
by the bears, the market decided that the end of the war signaled a turning
point in effectiveness of economic stimulus, and has been betting on an
economic recovery since the first week of March. Based on June quarterly
numbers from about one third of the large cap companies, it seems an earnings
recovery is definitely underway. Here are the facts:
As of last Friday one third of the
companies trading on the S&P 500 had reported June numbers. According
to S&P Global, estimates for the trailing four quarters operating earnings
for the S&P 500 is now $47.67. This is the broadest measure
of the corporate performance in large cap stocks.
According to Thomson Financial, the
current consensus of analysts' estimates for the S&P 500 for the next
four quarters is now up to $57.10. Therefore, the market is anticipating
operating
earnings for the S&P 500 is estimated to be growing at nearly 20%.
Earnings growth always leads to appreciating stocks.
I use the operating earnings number
because that is the best measure of the true health of a business, and
the one the market keys on.
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P/E
Should Really Be B/S |
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The Bull/Bear debate rages on. Bulls
point to earnings and argue unprecedented fiscal stimulus will work. Bears
keep arguing a bull market can't start until large cap stocks trade at
a P/E of 8.
I don't know who is right, but I
do know this: This single most misunderstood and misused measure of a stock's
potential value is the "P/E Ratio". It should really be called the
"B/S
Ratio".
If you only take one thing from the
OTC Journal in all the editions you ever read, take this- The P/E ratio
of a stock means nothing. P/E ratio stands for Price to Earnings. Most
people believe a stock can be considered undervalued if the P/E ratio is
about half the growth rate. Another words, if a company had a P/E ratio
of 10, and a growth rate of 20%, it could be considered undervalued.
I first learned the uselessness of
this ratio in about 1987. I was considering investing in a stock trading
at about $40 per share. A friend discouraged me when I told him the P/E
ratio was 2500. He promptly informed me he was a very successful investor,
and would never buy any stock trading with a P/E of 2500. He told me I
should have my head examined.
Needless to say, the stock traded
to about $250 within one year without me. Split adjusted, the stock I was
looking to buy at $40 has a current price equivalent of $.50, and is now
at $70. The name of the company is Amgen for those who are interested.
This is when I learned how useless P/E ratio is as an indicator of future
price performance.
In my opinion, the rule of thumb
for determining if stocks will go up is very simple. Stocks go up
when investors believe the future looks better. Stocks go down when investors
believe the future looks worse. Investors started to believe the
future could look better last October, and have become more convinced since
the beginning of March. Therefore, barring any more cataclysmic events
(911, Enronitis, War with Iraq, etc), the market is now prepared to buy
into earnings growth after a three year absence.
Right now we are in the midst of
the summer grind. Business slows with vacation time. Volume is way down.
The earnings you are reading about today were already priced into stocks
during April, May, and June. The bond market is catching all the action.
Long term bonds are getting clobbered as the market anticipates an economic
recovery and higher interest rates in the future.
September is usually is a tough month.
I believe October will mark the beginning of a major multi month run up
in the markets.
Here's a quick overview of the technical
analysis you might find helpful:
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A
Quick Lesson on the Technical Side |
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When evaluating the market in general
or any stock, there are two sides to look at: the fundamental and the technical.
For the most part, traders are only technical. They believe you can predict
where a stock will go simply by identifying patterns that repeat themselves,
rather than looking at corporate performance. I like a combination of the
two methods. I like to invest in companies with a great deal of fundamental
upside at a favorable technical entry level.
Market technicians are a strange
breed. They claim it's a science, but technical analysis is really an art
form. You have to find a style or method that works for you and be disciplined.
You can look at stochastics, support/resistance, moving averages, Elliot
waves, MACD indicators, candlesticks, Bollinger Bands, oscillators, etc.
It is all very confusing, and takes an enormous amount of time and energy
to learn.
I use simplistic technical analysis.
I like stocks and the market who's highs are getting higher, and who's
lows are getting higher. I like trends. Here are the two simple technical
factors I like to look at and use frequently for readers of the OTC
Journal:
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The
Support Line |
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Alongside is a chart of the NASDAQ
Composite as measured from the March low when the current uptrend started.
The Red line I have drawn in is the support
line, which defines the uptrend.
Note that each and every time the
market dropped back to that line, it bounced back up. I believe that until
this line is solidly breached for several days, the uptrend is still intact.
It is amazing how accurately Monday and Tuesday's drop took us right back
to the trendline, which was followed by a rebound. This chart tells me
the current uptrend is still intact until proven otherwise. This performance,
coupled with projections of 20% operating earnings growth for the S&P
500 over the next year, has me convinced the Bear Market is over.
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The
50% Retracement Rule |
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Here's another chart of the NASDAQ
Composite with Support/Resistance lines drawn in. I believe this becomes
useful when the short term trend line is broken to the downside.
The trendline I showed in the chart
above will eventually be breached. There will be a short term trend reversal
to the downside at some point in time. I don't know when it will be.
When it happens, I will be looking
for the market to give back about 50% of its gains during the life of the
trend. 50% is not an exact number, it is a range, which is why this chart
has three lines in the middle. Those lines show the range.
Therefore, if the market were to
break solidly below the trendline shown in the first chart, I would be
looking for a pullback into the middle of the range, or a 50% retracement
of the previous gains. If it were to start happening tomorrow, I would
look for the NASDAQ to grind down into the 1520 range at which point you
would have a low risk entry level. As long as the Bull Market remains intact,
another uptrend would begin at some point in the future.
In my opinion, a break below the
trendline shown in the first section would not mean the long term trend
had reversed. It would simply mean the market was advancing into a long
overdue corrective phase, and offer an opportunity to accumulate at reasonable
prices.
If the market were to break solidly
below the bottom line of the three in the middle, I would start to worry
about the validity of this new Bear Market, and might take my money off
the table until the smoke cleared.
The charts I have shown you can be
drawn any way you want over any time frame, and can be applied to any stock.
I believe you should look at longer term charts if you are looking to make
longer term investments. For short term investments you should look at
short term charts.
There are stocks I plan on owning
for three days, and others for three years. Unless I get really lucky,
I generally don't day trade. I've tried it, and I'm bad at it.
In the little universe of stocks
I cover, you should pick out a few you really like. Instead of buying along
with everyone else when there is news and the stock is hot, try accumulating
when prices drop to trendlines or 50% retracements coupled by light volume.
Sell a little when they trade well to get your cost basis down. If you
become good at it, you could own a whole portfolio of microcaps with little
or no cost basis. Also, as I learned the hard way from the Amgen
story, don't be afraid to own stocks for the long term.
Several good free resource sites
for charting stocks include www.smallcapcenter.com,
www.stockhouse.com,
and www.bigcharts.com.
Charts Provided Courtesy
Of TradePortal.com |
